Finance Security

Very commonly individuals personally-borrow money and then loan that money on to their new entity to say: buy a business, acquire equity, help provide a loan for working capital to help privately fund their business etc.

However I still find it very rare that (despite their being a ‘bank’ for their business entity and usually seeking their accountant’s advice) individuals actually act like a bank, and also put in place the requisite finance document and security arrangements from the outset.

Further I can absolutely assure you that a ‘loan’ merely written into a balance sheet has zero security effect…

Example:

1. Mum and Dad are directors and shareholders (say through a family trust) of a newly-formed Company and they wish to buy a business with the Company.

2. They use their home as both a source of equity to obtain a loan from a bank and establish a personal line of credit.

3.  Mum & Dad then effectively:

  • on-lend this money to their new Company (i.e. an entirely separate entity but they think “Well, it’s my company too.  So what do I have to worry about…”) to buy the business yet their informal/undocumented loan is not secured against their buyer Company…

* However the last thing you want to see is that later on down the track then other parties (e.g. overdraft financiers, a lessor, franchisor, suppliers etc) have subsequently secured priority on the  Company over and ahead of Mum and Dad.

4. Therefore there needs to be:

  • a relatively simple yet nonetheless, written, Loan Agreement and at the very least it should clearly specify:
  1.      the amount of money advanced (and when),
  2.      the commencement date and term of the loan,
  3.      the interest rate (at least as high as their bank is charging them personally),
  4.      whether it is a principal & interest or interest-only loan,
  5.      the manner of repayment of the interest and principal
  6.      effects of default and termination
  7.      any special conditions (obviously there are number of other highly-recommended provisions that should go into a good, contemporary commercial loan agreement).
  • with an incorporated General Security Agreement (“GSA”) over the all the ‘personal property’ in the Company
  1.     (i.e. all the non-land assets that it will be buying present and any assets it may also acquire/own in the future (e.g. cash, goodwill, debtors, IP etc) under the Personal Properties Securities      Act.  This is known as ‘all present and after-acquired property’ (“AllPAP”) and was formerly known as a ‘fixed & floating charge’.
  2.     Alternately, if the particular asset the Company was going buy was land (i.e. real property) then they would still need a Loan Agreement but this time they would have a Mortgage as the            security instrument.  Of course you can have both a GSA and a Mortgage, depending on the assets of the Company.
  • between Mum and Dad (Lenders) and their New Company (Borrower) asap!

5.  With all the relevant information provided an experienced Securities Lawyer can have the required Loan Agreement and GSA prepared usually within the day; subject to complete instructions.       And, once signed or electronically accepted by the parties, to properly register it on the Personal Properties Securities Register (“PPSR”), it can be done in much less than an hour.

6. Pro tip: Make sure that all loan documents are signed and the security interest registered on the PPSR at or even just before the loan advance!

7.  Lastly please note that trying to retrospectively formalise and ratify any such loan security arrangement, once the Company is already in financial distress and/or technically-insolvent, may be         ineffective. I usually call that situation a need for ‘fiscal palliative care’. Please don’t go there.